Let’s put it this way: the combined eBay and PayPal entity presently listed under the ticker symbol eBay (EBAY) is cheap.
The combined company is trading in the mid-$50s with a market capitalization of ~$69 billion at present, and we value its shares in the mid-$70s (a ~$90+ billion valuation). We’re not the only one, in case you think that, despite everything we seem to get correct, we’re off our rockers with this valuation. Stifel, for example, recently labeled $75 per share as an upside case for the company. eBay remains a holding in the Best Ideas portfolio, and the equity markets are simply getting the company’s valuation wrong, in our view. It is one of the few true bargains left on the market today.
You can dig into our forecasts of eBay’s valuation on the firm’s landing page here, but in a market where steady-eddy firms with modest growth potential are trading in the high-teens as a multiple of forward earnings, eBay, despite growing at a nice double-digit pace on the top line is trading for less than 17 times next year’s earnings. Holiday comps at eBay also continue to be strong, with ChannelAdvisor reporting a nice 15% jump from November 27 through December 7 at the online marketplace giant. Impressively, eBay’s comparable store sales advanced by more than 20% during Cyber Five (November 28 through December 2), roughly in-line with that of Amazon (AMZN) – a very nice showing. So what gives? Why isn’t the market giving eBay credit for its fantastic cash-flow profile and expanding businesses.
There are several reasons, in our view: 1) Carl Icahn launched an ugly battle with management that created mostly negative publicity and resulted in a value-destructive re-domiciling of foreign cash (a huge tax blunder), 2) the impact of Apple (AAPL) Pay and Facebook’s (FB) long-term efforts in mobile e-commerce on PayPal’s business remains to be seen, which is generating a great level of fair value uncertainty, 3) eBay is having a difficult time shrugging off its legacy auction-stigma past, which in our view, could very easily be overcome with a simple name change, and 4) the sell-side had peculiarly been against separating eBay and PayPal in the past (in accordance with management’s views at that time), but now management has outlined expectations that it will be splitting the two entities. The analyst community is confused.
Enter Yahoo. It appears that Starboard’s efforts to rein in Yahoo’s spending have failed, and we applaud Marissa Mayer for standing her ground. Most great CEOs have a vision for their firms, and even if we’re not quite sure of the direction of Yahoo just yet, the board must be satisfied with it. For one, the board just approved a $640 million deal with BrightRoll, which is expected to generate only $100 million in sales during 2014. At more than 6 times revenue, that’s an expensive purchase, but it does speak to the fact that the cash coffers are open at Yahoo regardless of some of its large investors’ wishes and hopes that it would combine with AOL (AOL).
Let’s get to the point. Yahoo’s remaining stake in Alibaba (BABA) is 384 million shares, which is worth nearly $41 billion based on market prices. Selling the shares outright would result in a large capital gain and a hefty tax bill, so Yahoo isn’t going to go that route, in our view, especially given Starboard’s letter. Instead, we think it will use the shares as currency and scoop up another publicly-traded company, much like Warren Buffett did with Duracell. Which firm, you may ask? We think it will be the soon-to-be-split PayPal (or the legacy eBay). Starboard’s letter to Yahoo went public in late September, and news hit that eBay and PayPal would split only a couple weeks after that, even as management shot down Icahn’s efforts to do the same earlier this year. Is the timing of the abrupt shift in opinion coincidental? Perhaps. But is it also possible that talks between Yahoo and eBay are happening at this very moment. We’d even say it’s probable, especially as Mayer looks to generate measurable shareholder value.
Are we acting on this speculation? No. But we continue to include shares of eBay and Alibaba in the Best Ideas portfolio, and while we can dream up scenarios related to where Yahoo will spend its cash hoard or use its shares as currency, we won’t know for certain until a press release actually hits the wires. In any case, look for Yahoo to use its Alibaba shares wisely in a tax-efficient deal for a company or for part of a firm that has recently carved off operations. Shares of Yahoo are trading just north of our estimated fair value range at the moment, so we don’t view them as attractive from a valuation standpoint.
Stay tuned! This could get exciting!